A blog designed to provide an outlet for Jeff's and other unvarnished opinions on community financial institutions. Sometimes serious, other times not, Jeff's opinions are his own and may not represent the opinions of his esteemed employer.

Thursday, January 12, 2012

Guest Post: 4th Quarter Economic Update by Dorothy Jaworski

Before looking ahead to 2012, I can’t resist the traditional temptation to look back at the past year. The markets in 2011 were dominated by earthquakes and the tsunami in Japan, spikes in gas and oil prices, historic Federal Reserve actions where they “promised” to keep rates at their current low levels until mid-2013 and “Operation Twist,” where they are selling their shorter maturity holdings and buying longer term ones in an effort to drive down long term interest rates, and a debt ceiling and deficit debacle where our leaders in Washington cost our nation its precious AAA rating.

These events led to the stock market taking a beating of -12% to -14% in the third quarter, but a fourth quarter recovery of +8% to +12% and a Santa Claus rally of close to +1% saved the day. Volatility, anyone?

Actually, the Dow Jones Industrial Average was the only major stock market index in the world to increase in 2011. The S&P 500 index came in a close second at a change of zero. Europe suffered losses on average of -6% to -17% while Japan, China, and other Asian nations saw declines of -15% to -25% on average. Returns in the bond market were much greater.

Our weak economic growth of about 1.5% in 2011, Federal Reserve actions, and constant worry and fear about the European sovereign debt crisis caused our “beyond crazy low” rates to fall further, with the 10 year Treasury yield ending 2011 at 1.88%, after falling 144 basis points during the year, and returning about 10% to investors.

These rate declines may seem incredible, except when you consider that the Federal Reserve has their foot on the gas with quantitative easing programs I and II, their “promise,” and their $400 billion “twist” operations. Their ultimate goal seems to be a reduction in mortgage rates to help spark a housing market recovery; mortgage rates lagged the change in Treasuries in 2011 by falling 105 basis points. As they say, “don’t fight the Fed,” especially when they are “over-easing.”

Businesses fared okay in 2011. They survived tight credit, lack of confidence, and over regulation to take GDP to record levels, to take corporate profits to record levels, and to make lots of cash so that they can hoard it on their balance sheets to the tune of $2.1 trillion at the end of the third quarter. They are not alone as hoarders; banks hold an equal amount in excess reserves at the Federal Reserve.

Collectively, in May of 2011, we came to the realization that we have spent $3 trillion in the past fifteen years fighting his brand of terrorism, but we finally got Osama bin Laden. For him, terror came in the dark of night in the form of our Navy Seals. Geronimo EKIA.

Consumers fared okay in 2011, too. Unemployment fell to 8.6% in November, 2011 from 9.8% in November, 2010, although we are still seeing people exit the labor force, or go “MIA,” which is highly unusual during a recovery. Consumer spending rose, albeit slowly at times, in every month except one (June) during 2011.

Shoppers came out in force on Black Friday to set new spending records for that day at $11.4 billion, up 6.6% year-over-year. Auto sales have returned to annualized levels above 13 million. Just don’t mention the value of their homes and they will be okay. And who can forget getting up in the middle of the night in April to watch live as Prince William married Kate Middleton—a boost indeed to economies everywhere!

Looking Ahead to 2012

The sheep followed their annual ritual of falling all over each other to get their GDP forecasts out for 2012. They can be a pessimistic bunch, especially the group from AP. Here are their forecasts:

- Federal Reserve 2.5% to 2.9%

- Blue Chip Economic Indicators 2.0%

- National Association of Business Economics 2.4%

- Associated Press Survey of Economists 1.3%

- Wall Street Journal Survey of Economists 2.3%

We remain in the midst of a recovery that is fragile and susceptible to shocks. But I will emphasize that slow growth is not recession. Don’t let the pundits make you think it is. GDP is at a record level of $15.2 trillion (current dollars, seasonally adjusted). Corporate profits are at a record 13% of GDP, compared to the average since 1947 of 9.5%. Job creation has been slow, but steady. In the first six months of 2011, payroll employment grew on average by 131,200 each month, while household employment grew on average by 21,300 each month.

For the period of July to November, the pace for payrolls remained about the same on average at 132,200 and household employment increased dramatically to average 249,200 monthly. The employment picture is slowly improving.

Consumers spent freely for the holidays and it remains to be seen whether they remain in a festive mood or return to their dour deleveraging habits. The Federal Reserve is determined to keep interest rates low so consumers can borrow or refinance cheaply, and just maybe people will buy houses to get the excess inventory off the markets.

As far as the bond markets go, rates, while they can still go lower, probably will not because they are already less than the most recent core rate of inflation of 2%. Mortgage rates may not fall further as investors seem averse to such low rates that bring with them greater duration risks.

As far as the stock markets go, prices, while they can go lower, probably will not because the price earnings ratio of the S&P 500 is already below average at 12 times and the dividend yield of 2.1% is greater than the ten year Treasury yield of 1.88%. GDP is at a record dollar level and corporate profits are at a record when compared to GDP.

There are always wild cards such as the “next” crisis, reduced government spending, and the Presidential election this year. Don’t give up on the economy—there are enough positive signs of future growth and a Fed with their foot on the gas pedal. Stay tuned!

And, in case you have not noticed, she has been quietly moving into mainstream America, with a primetime Thanksgiving night special and a performance on TV on New Year’s Eve wearing what appeared to be a giant birdcage. Lady Gaga is about to announce and embark on a 2012 tour and I am there!

Thanks for reading! DJ 01/03/12

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with First Federal of Bucks County since November, 2004.

About Me

Jeff started his banking career in the IT Department of a northeast regional bank in 1985. His banking experience includes IT, Trust, branch management, and merger integration. He has served as a consultant to the banking industry since 1997, specializing in strategy development, M&A, and profitability. He interrupted his banking career to serve in the U.S. Navy, the best Navy in the world, where he specialized in intelligence gathering against very bad people. He lives in Lancaster County, Pennsylvania with his wife and two children.